Retiring with multiple streams of income will make your golden years a lot more comfortable. You don’t want to rely on Social Security alone, given that the average monthly check was just $1,657 for retired workers as of January 2022.
One good option is to earn dividend income. Even an extra $500 a month could make a big difference to your retirement budget.
Dividend-paying stocks and funds are ideal for retirees’ portfolios for two reasons. The obvious reason is that dividends are a source of passive income. But companies that pay a dividend also tend to be financially stable, making them a great choice for retirees who don’t want much volatility. Read on to learn how to generate $500 a month of dividend income in five easy steps.
1. Plan for the tax bill
First, the bad news: Dividend income is taxable, so unless you want to send the IRS a cut, you’ll need to plan ahead.
Fortunately, there’s an easy way to avoid a future tax bill. Give up the tax break now, and invest after-tax dollars in a Roth IRA. As long as you hold the account for five years and wait until you’re at least 59 1/2 to start withdrawing your earnings, the money you earn through capital gains and dividends will be tax-free.
2. Set your investment budget
Let’s assume you want your portfolio to generate a dividend yield of 3% when you retire. If your goal is to earn $500 a month, or $6,000 per year, you’d need at least $200,000 of dividend-paying investments. Now it’s time to make a monthly investment budget.
Obviously, the earlier you start, the easier this will be. If you start investing 30 years before you retire and earn 8% annual returns, you could get to $200,000 by investing less than $150 a month. But if you wait until your retirement is 20 years away, you’d need to invest nearly $350 to reach your goal.
3. Maximize growth during the early years
Generating dividend income shouldn’t be your goal when you’re decades away from retirement. Instead, you want to maximize the growth of your investments. You could start out with a simple S&P 500 index fund, or you could use a growth investing strategy. Whatever approach you choose, you should reinvest any dividends you earn to fuel your returns early on.
4. Gradually shift to dividend investments
In the five to 10 years before retirement, you’ll want to start shifting your money into dividend-paying investments. Diversification is key here. A company can cut or suspend its dividend at any time. So you can’t rely on just a couple of stocks if you’re counting on dividend income.
Investing in dividend index funds is a smart move. You’re investing in a basket of securities with a history of dividend payments, so if a handful of companies reduce or eliminate their dividends, the impact on your income is minimal.
If you’re investing in individual stocks, don’t look for those with the highest yield. That ultra-high yield is often what’s known as a dividend trap. The share price may have tanked, leading to an unusually high dividend yield, or the company’s dividend payments may be unsustainable.
A better strategy is to invest in Dividend Aristocrats, which are companies that have increased their dividends for at least 25 consecutive years. Of course, that doesn’t mean they’ll be able to increase their dividends for eternity. But once a company reaches the coveted Aristocrat status, they usually have a good incentive to keep those dividend hikes coming.
5. Cash in on your dividends
Once you’ve reached your investment goal and are ready to retire, it’s time to start cashing in on those dividends. Quit reinvesting your dividends and start using the money your investments are earning to pad your retirement budget.
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